Magnetar’s (Nearly) Perpetual Money Machine
By buying the risky bottom slices of CDOs, Magnetar didn't just help create more CDOs it could bet against. Since it owned a small slice of the CDO, Magnetar also received regular payments as its investments threw off income.
With this, Magnetar solved a conundrum of those who bet against the market. An investor might be confident that things are heading south, but not know when. While the investor waits, it costs money to keep the bet going. Many a short seller has run out of cash at the gates of a big payday.
Magnetar could keep money flowing -- via its small investments in CDOs -- and could use that money to pay for its bets against CDOs.
Similar, commonly traded, assets appeared in multiple Magnetar CDOs. Experts say the benefit of that overlap to Magnetar was that when the hedge fund bet against non-Magnetar CDOs, the CDOs still had similar characteristics to the ones Magnetar had invested in.
Soon enough, bankers and CDO managers had a sense of how it worked. "Everyone knew," said one person who managed Magnetar CDOs. "They used the equity to fund the shorts."
Magnetar further increased its odds by insisting that the CDOs it helped create had an unusual construction. Typically, cash flowing to the last-in-line equity buyers is cut off at the first signs of trouble -- such as a rise in mortgage delinquencies. Those at the top of the CDO -- who accepted lower returns for less risk -- received that cash, leaving none for the high-risk holders.
Magnetar wanted its deals to be "triggerless," meaning lacking these cash-flow dams. When the market turned shaky and homeowners began to default, money kept flowing down to the risky slices that Magnetar owned.
Even today, bankers and managers speak with awe at the elegance of the Magnetar Trade. Others have become famous for betting big against the housing market. But they had taken enormous risks. Meanwhile, Magnetar had created a largely self-funding bet against the market.
Enticed by profits and bonuses, Wall Street took advantage of complicated mortgage-based instruments to reap billions, only to exacerbate the eventual crash.
The Story So Far
As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse.
Latest Stories in this Project
Our Hottest Stories
- Segregation Now
- Beyond Ratings: More Tools Coming to Pick Your Doctor
- Rocky Mountain High or Reefer Madness? Legal Pot in Colorado Comes with Risks
- Even After Doctors Are Sanctioned or Arrested, Medicare Keeps Paying
- Long After Sandy, Red Cross Post-Storm Spending Still a Black Box
- Shake-Up Inside Forensic Credentialing Org
- Brooklyn DA Moves to Free Man after Long-Buried Evidence Surfaces
- The U.S. Government: Paying to Undermine Internet Security, Not to Fix It
- How the Labor Department Has Let Companies Off the Hook for Unpaid Internships
- Brooklyn Man Walks Out of Court, Cleared of Murder After 24 Years in Prison